Announce the elimination of LDPs and corn prices would jump immediately
With the Brazilian cotton case looming large over WTO agricultural
negotiations and thus over US farm bill discussions, we have been using this
column to outline the arguments that could be used if one were called upon to
provide expert testimony before a WTO disputes panel hearing a case against the
US corn, soybean, wheat and rice programs.
In the first column in this series, we identified the underlying characteristics
of crop agriculture. We then argued that looking at subsidies isolated from
these characteristics is like straining at gnats while swallowing camels because
numerous studies have shown that eliminating subsidies are not likely to reduce
US aggregate crop production nor raise prices.
If the elimination of mailbox subsidies would not lead to significantly
decreased production and the expected increase in the price of program crops,
then why have prices been so low? To a large extent it is because of the use of
Loan Deficiency Payments/Marketing Loan Gains (LDP/MLG).
In the mid-1990s, the non-recourse feature of the loan program was rendered
ineffective by the extension of LDP/MLGs to corn, wheat and soybeans among other
crops. Instead of forfeiting ownership of a crop whose price fell below the loan
rate to the government in exchange for the government writing off the decrease
in collateral value, the LDP/MLG allowed the farmer to retain ownership of the
crop with the government paying the farmer the amount it would have written off.
This shift in policy was seen as positive change. It saved the government the
cost of storage of forfeited grain, and it allowed the farmer to capture any
gain in value if the price of the crop increased. In addition it was argued, the
use of LDP/MLGs would allowed the US price to match the world price enabling US
producers to recapture lost market share in these crops. The logic behind this
was based on the belief that the US loan rate artificially held the US price
above the world price, resulting in lost marketing opportunities.
The belief was that the world price was set by international supply and demand
conditions apart from the US price. And if the US rendered the loan rate
ineffective in setting a floor on prices, the US price would be the same as the
world price. This would allow the US share of the export market to increase
significantly because it was no longer locked out by artificially high prices.
The problem with this line of reasoning is that it failed to understand the role
of US markets in setting the “world price.” There is ample evidence to suggest
that the US is the oligopoly price leader for most temperate agricultural crops.
Because of its control over a large portion of the supply, the oligopoly price
leader sets a virtual ceiling on prices and all other competitors price off the
leader. In most cases, unless they offer a premium product, the price for
competitors is below that of the price leader.
As US prices fell from their 1996 highs, the prices of our export competitors
fell as well, staying below the US price for the bulk of their sales. As the
prices plunged below the loan rate during the 1998 crop year, it was expected
that two things would happen: (1) our export competitors would reduce their
acreage or at least slow down their rate of acreage expansion, and (2) the lower
prices would enable to capture additional sales and our competitors would end up
holding additional year-ending stocks. Neither thing happened even though prices
stayed below the loan rate for the most of four years.
In the absence of a supply crisis, once the price fell below the loan rate,
grain purchasers had little incentive to bid the price up. From their
perspective, as long as the price stayed below the loan rate, the US government
was in effect subsidizing their purchases.
Farmers, too, had little incentive to see prices rise above the loan rate
because the lower the posted county price, the greater the LDP/MLG they could
capture. To make more than the loan the farmer needed to wait to sell until the
price was greater than the posted county price when they took the LDP. For
farmers who had forward contracted their crop at a higher price, it was like
shooting fish in a barrel.
While LDP/MLGs provided little incentive for US farmers to increase their
aggregate plantings, they did protect them from the ravages of sub-loan rate
prices. Farmers in the rest of the world were not so fortunate as they had to
take the lower prices; Thus, the charges of US dumping of crops at prices below
the cost of production.
We are not arguing that the US commodities were not sold at prices below the
cost of production. They were. What we are arguing is that the problem is not
farm program benefits themselves, but rather the mechanism by which they are
distributed. If the US were to announce that it was going to scrap the LDP/MLG
programs at the end of the current crop year and allow the non-recourse loan
program to function, the impact would be immediate. Corn prices would jump from
their current local prices in the $1.65-1.75 range to over $2.00.
Adhering to a faulty WTO-focused analysis and eliminating all subsidies is like
throwing the baby out with the bath water. No one will be better off and many
will be worse off. A better solution would be to eliminate the offending LDP/MLG
program allowing the non-recourse loan rate program to set price floors for US
farmers and farmers around the world.
Daryll E. Ray holds the Blasingame Chair of Excellence in Agricultural
Policy, Institute of Agriculture, University of Tennessee, and is the Director
of UT’s Agricultural Policy Analysis Center (APAC). (865) 974-7407; Fax: (865)
974-7298; dray@utk.edu; http://www.agpolicy.org. Daryll Ray’s column is written
with the research and assistance of Harwood D. Schaffer, Research Associate with
APAC.